Directors and Officers

How (and how often) should directors and officers be trained on COIs? What general lessons and what sorts of examples should be used in such training and other sorts of C&E communications to company leaders?

First, the Wall Street Journal reported last week: “Generic-drug maker Mylan NV moved into new headquarters in December 2013 after buying vacant land in an office park near Pittsburgh and erecting a five-story building for about 700 employees. The company hasn’t publicly disclosed that the office park’s main developer is Rodney Piatt, Mylan’s vice chairman, lead independent director and compensation-committee chief. The new headquarters was a big boost for the mixed-use real-estate development, called Southpointe II, where all the land has been sold and some of the last buildings are now rising.” As the article further describes, Piatt sold his interest in two parcels to a business partner for nominal amounts, who in turn sold the parcels to Mylan for several million dollars each, but that does not mean that Piatt received no benefit from the dealings: “Mylan’s decision to build the new headquarters may have helped boost the value of Mr. Piatt’s other holdings in [the development]. After local officials in 2011 approved permits and rezoning for a plan that included the headquarters, a firm managed by Mr. Piatt sold a nearby hotel for $14.8 million, property records show. Mylan’s plans helped spur interest from retailers to sign leases, says… the business partner of Mr. Piatt. ‘The more people there are in offices, the more demand there is for lunches’ and other services,… .”

While there is presumably more to this story than what appears in the article, it is hard to argue with the take of corporate governance expert Charles Elson: “’The optics are terrible. Pittsburgh is a big town with no shortage of real estate. Either they could have gone somewhere else, or [Mr. Piatt] could have relinquished the directorship and eliminated the conflict.’”

The second article – which appeared this past weekend in the New York Times – is no less interesting: “Consider a document recently filed in a 2013 shareholder lawsuit against directors of Dish Network, the television provider based in Englewood, Colo., which contends that the company’s co-opted board cost its investors at least $800 million in one recent episode. The document also provides some seriously good, well, dish on personal and family ties between Charles W. Ergen, the company’s co-founder and chief executive, and two Dish directors the company identifies as independent in its regulatory filings. Lawyers for Dish shareholders found, for example, that the family of Tom A. Ortolf, a director who is head of CMC, a private investment firm, has taken numerous hiking trips with Mr. Ergen’s family. Another fun fact unearthed in the case: Four invitees to a 17-person bachelor party for Mr. Ortolf’s son were Ergen family members. Then there’s the note Mr. Ortolf sent after Mr. Ergen offered two Super Bowl tickets. “I love you man!” the director exulted. George Rogers Brokaw, a managing partner at Trafelet Brokaw & Company in New York, is another independent Dish director with personal ties to Mr. Ergen. Mr. Brokaw’s family hosted members of the Ergen clan at their homes in New York City and the Hamptons, the lawsuit says. Mr. Brokaw also provided advice on a job search to one of Mr. Ergen’s children. Cantey Ergen, Mr. Ergen’s wife and a Dish co-founder who is also a director at the company, is godmother to Mr. Brokaw’s son.” The Times piece further describes: “The close relationships between Mr. Ergen and his directors might not have mattered so much if not for a private investment he made in 2012 [which, the shareholders contend in their suit, represents a usurpation of a “corporate opportunity” belonging to the company] “that could generate personal profits for Mr. Ergen of perhaps $800 million. After shareholders sued, contending that the transaction was a breach of the chief executive’s duty to Dish, a special litigation committee of the company’s board was formed to investigate the deal. As it turned out, Mr. Ortolf and Mr. Brokaw were appointed to two of the committee’s three posts.”

There’s lots to be said about director conflicts (see prior posts collected here) but perhaps the overarching point is that a big part of the reason that the position of corporate director exists is to ameliorate the conflict-of-interest-like “agency problem” that comes from executives managing other people’s (i.e., shareholders’) money. Since directors’ COIs can raise questions about the ability of a board to perform this vital function, they can be especially pernicious. For this reason, it is part of a director’s job, I believe, to avoid situations that give governance experts like Charles Elson just cause to berate them publicly for creating terrible optics, as he did the Mylan directors. Put otherwise, directors have to be attentive not only to actual COIs but apparent ones too.

Of course, every member of a public company board would swear that they are familiar with this principle. But what is less well appreciated is just how difficult mitigating an apparent conflict can be – and particularly so for powerful people with complex business dealings. For more on what is involved in mitigating apparent COIs see this earlier post. On the other hand, maybe the Mylan board did understand how challenging mitigating the apparent COI facing them would be, and so opted for non-disclosure. Of course, once uncovered, non-disclosure itself contributes to the appearance of wrongdoing.

Turning to the other case of the week, while the Dish directors might feel that the various purely social ties described in the Times piece are not the stuff of conflicts, the conception of COIs under Delaware law does indeed encompass non-financial relationships, as established by an important (but sometimes forgotten) case in 2003 involving the directors of Oracle. As described in this article about fiduciary duties, the court there held that “a director must base his or her decision on the merits of the subject matter rather than ‘extraneous considerations or influences’ and that a director may be ‘compromised if he is beholden to an interested person.’ Most importantly, the court stated that ‘[b]eholden in this sense does not mean just owing in the financial sense, it can also flow out of ‘personal or other relationships’ to the interested party.”

In the vast realm of conflicts of interest those involving boards of directors tend to stand out. That is because part of the reason the role of corporate director even exists is to mitigate the conflict-of-interest-type tensions (which fall under the broad heading of “agency problems”) that managements may have vis a vis shareholders. Moreover, while the role of officers obviously differs somewhat from that of director, the duty of loyalty that both owe shareholders is the same.

Director and officer COIs can arise in many settings but often the most consequential of these involves mergers. And, as described in a post last week in the D&O Diary: ”Within the past few days, two merger objection settlements – one involving Activision Blizzard, Inc. and the other involving Freeport-McMoRan, Inc. — have been announced involving massive cash payments,… The Activision settlement may represent the largest cash settlement payment ever in a shareholder derivative lawsuit.” The post further describes that “[t]he common feature of these two cases that may account for the magnitude of the cash payments seems to be the conflicts of interest that were alleged to be part of the challenged transactions.”

The specific facts of these two cases – both of which are complex, as COI cases involving mergers typically are – may be less important than is what they (and another one last year involving News Corp, which is discussed in the same post) may mean for insurance costs to companies: “The rise of jumbo shareholder derivative lawsuit settlements has a number of implications. Among other things, it is a topic that will have to be taken into account as D&O insurance buyers consider how much insurance they will need to ensure that their interests are adequately protected.”

While most directly relevant to risk managers and others in companies in charge of securing D&O coverage, I think C&E professionals also need to know about this development – because directors and officer of their companies likely will and will be concerned about it. And, hopefully this awareness will contribute to a greater overall sensitivity at high levels in companies to COIs generally – meaning that this may be a good time to train (or retrain – or schedule training of) your directors and officers on COIs.

For those looking to develop such training, here is a prior post on that topic. And here are some other posts, portions of which might provide helpful ideas or information for training boards on COIs:

King Herod the Great had something of a problem: he had backed the losing side in the contest between Marc Antony and Octavian to rule Rome, and now fully expected to lose his life for it. But, as described in Jerusalem: the Biography, by Simon Sebag Montefiore, when they met he cleverly asked Octavian “not to consider whose friend he had been but ‘what sort of friend I am.’” Octavian was evidently persuaded by this, for not only was Herod’s life spared but the size of his kingdom was increased.

Loyalty is, of course, fundamental to friendship. But, while potentially more physically dangerous in the Roman Empire than it is today, friendship in our world can be ethically treacherous.

In “Will Disclosure of Friendship Ties between Directors and CEOs Yield Perverse Effects?” (to be published in the July 2014 issue of the Accounting Review), Jacob M. Rose, Anna M. Rose, Carolyn Strand Norman and Cheri R. Mazza describe how they conducted thought experiments involving both actual corporate directors and MBA students to determine whether “directors who have friendship ties with the CEO [are more likely that are directors without such friendships] to manage earnings to benefit the CEO in the short term while potentially sacrificing the welfare of the company in the long term” and also whether “public disclosure of friendship ties mitigate or exacerbate such behavior, and will disclosure of friendship ties influence investors’ perceptions of director decisions.”

Sadly but not surprisingly, their research found “that friendship ties caused directors to be more willing to approve reductions to research and development (R&D) expenses that cause earnings to rise enough to meet the CEO’s minimum bonus target more often than when the directors and CEO were not friends.” Seemingly more of a surprise, they also found that “disclosing friendship ties resulted in even greater reductions in R&D expenses and higher CEO bonuses than not disclosing friendship ties.”

But this latter finding is not so surprising – given other behavioral research showing that disclosure can “morally license” individuals to act inappropriately when faced with a conflict of interest ( as discussed in this and other prior posts.) As described in a recent piece in the NY Times by Gretchen Morgenson, one of the study’s authors explained: “When you disclose things, it may make you feel you’ve met your obligations…They’re not all that worried about doing something to help out the C.E.O. because everyone has had a fair warning.”

Morgenson added: “There are two messages in this study. One is for regulators: Simply disclosing a conflict or friendship does not eliminate its potential to create problems. The other,” again quoting one of the study’s authors (but echoing Herod) “is for investors: ‘Shareholders should take a more active role in finding out what kinds of relationships their boards and C.E.O.s have…and recognize the potential traps created by them’.”

For more on conflicts of interest and directors see the posts collected here.

I’m not one who sees ethics and compliance as operating in wholly distinct spheres, and have long felt that they closely complement each other. (For more on the general relationship between the two see this piece from the SCCE’s C&E journal.) But, of course, they are not the same thing, and to some extent each has reach that the other doesn’t.

More specifically, for any given organization, the boundaries of compliance are – to a significant extent – defined by risk assessment. Compliance-related risk assessment can and should be done in an expansive and innovative manner (as discussed in this complimentary e-book) but it is ultimately finite in ways that are less applicable to true ethical standards. And when it comes to CEOs – who have near infinite capacity for engaging in mischief in their companies – the latter form of protection can be particularly important.

Not being statistically adept, I have nothing to add about the specifics of this case (other than to say I hope the company’s board conducts an independent inquiry of the matter). Rather, I mention the story because I have to believe that this sort of conflict of interest – assuming, for the purposes of discussion here, that the theory of wrongdoing is well founded – is unlikely to show up in most risk assessments, and thus this illustrates the earlier point about the limits of compliance. But from an ethics perspective, no CEO (or board member or “gatekeeper”) could reasonably believe that gaming a 10b5-1 plan in this way was okay, as it would involve using the company’s resources for purely private purposes (clearly an ethical breach – but perhaps less easily shown to be a legal one).

Indeed, it is precisely because a COI like this is so unpredictable – the Times story seemed to suggest that it was indeed something new under the sun – that it is potentially harmful. That is, when an unforeseeable COI emerges it raises the question: If the CEO is capable of doing this, what other mischief is he or she up to?

What this means is that the primary damage to the shareholders is not whatever costs can be directly traced back to timing corporate announcements for the personal benefit of a executive – an exercise that would likely be too speculative to be meaningful; and, even if the costs were measurable, they would likely end up being a small amount. Rather, the harm flows from a general loss of trust by shareholders from learning that a CEO puts their interests second and – because a CEO can influence her company in so many ways – not being able to monitor all the avenues of possible betrayal that might exist.

Understanding that sort of more general harm is one of the important ways an ethical perspective can supplement a more narrow compliance-based one. And it is part of the reason that boards and senior executives need to understand the importance of truly operating pursuant with high ethical – as well as compliance-related – standards.

Finally, for those who’d like to read more related to this topic please see Scott Killingsworth’s excellent paper on C-Suite behavior, discussed and linked to in this earlier post.

To those in the C&E field, the notion that privately held companies could, as a group, be more ethical than publicly held ones seems implausible. After all, public companies are required by law to be transparent in ways that private ones are not – and are also required to have various compliance measures that are not mandated for the latter. Moreover, at least based on anecdotal evidence, when companies go from public to private they tend to cut back on their C&E programs.

But that might not be the whole picture. As mentioned in a post last week, research in a recently published paper – “The Value of Corporate Culture,” by Luigi Guiso, Paulo Sapienza and Luigi Zingales – found that public firms seem to have a greater difficultly in maintaining cultures of integrity than do private ones. In that earlier post we focused not on that finding but what could be described as the “headline” story of that piece: that “high levels of perceived integrity are positively correlated with good outcomes, in terms of higher productivity, profitability, better industrial relations, and higher level of attractiveness to prospective job applicants.” Today, we return to the article to consider what could be the cause(s) of the link between private ownership and ethical cultures – for which the authors offer three possible explanations.

First, they note that there could be greater integrity-related communications challenges facing a public company than a private one: “if a violation of internal norms is discovered in a public corporation, in deciding the punishment, the CEO has to send two signals: an internal one to the managers and employees that also serves as deterrent for future violations and an external one to the market that maintains transparency of internal procedures. The latter poses the risk of being (wrongly) interpreted by the market as the tip of an iceberg rather than an isolated episode, inducing the top manager to dilute the punishment and the internal message. These complications may weaken integrity norms in publicly traded companies vis-à-vis private firms.”

This is indeed an interesting possibility, and something that I’ve not heard before. But the very fact that I have not heard it mentioned previously – in more than two decades of advising companies on C&E matters, attending C&E conferences and otherwise keeping track of the field – makes me somewhat skeptical about it.

Second, the authors note: “Public ownership…changes …the trade-off between the costs and benefits of strict integrity norms… If… some assets are not considered (or underappreciated in the short term), public ownership creates a distortion in decision making…” They further argue that integrity may in fact be underappreciated in the market, so that “a CEO who allocates company resources to maximize the current stock market value of a company will tend to underinvest in integrity.”

Unlike the first explanation, this one seems virtually self-evident, given the absence of any meaningful indication (at least of which I am aware) that capital markets really give sufficient weight to integrity cultures. Fortunately, the above-noted “headline” finding of the authors’ research – linking ethical cultures with profitability and other desirable business outcomes – itself has the power to change that, at least if it becomes widely appreciated and further developed by practitioners and researchers.

Finally, they state: “public ownership comes with a separation between ownership and control and the CEOs of a public corporation are not always driven solely by shareholder value maximization, since they do not fully internalize the cost of deviating from value maximization.” This, too, seems compelling to me. It has its roots in Adam Smith’s powerful insight that “[M]anagers of other people’s money [rarely] watch over it with the same anxious vigilance with which . . . [they] watch over their own,” and is, of course, broadly consistent the notion of “moral hazard,” about which much has previously been written in this blog and elsewhere.

So, for C&E professionals what is the import of these findings?

For those who work in/with public companies I think the overriding lesson is that the board needs to be involved to a meaningful extent with the C&E program. That is because directors are generally far better able to resist the pernicious effect of short-terming thinking and “moral hazard” on a company’s integrity culture than is management. Of course, much has already been written about the need for strong board oversight of compliance. But, having the relevant data from this paper should help some directors who are under-involved with C&E see the business case for stepping up their game.

Many years ago, I heard a businessman who had been convicted of tax fraud describe how he and his confederates had, while their crime was underway, minimized the wrongfulness of what they were doing, which included backdating documents: we used to joke, he said, that we were so dedicated that sometimes we were still working as late in the year as “December 38th.” While perhaps a cute story (at least for this time of year) more relevant for C&E professionals (and to conflict of interest history) are the backdating cases which began in 2005/2006 and involved the retroactive dating of stock options issued to corporate officers to a time preceding a run-up in the price of the company’s shares. While the act of granting lucrative options was itself not itself problematic, the backdating was kept secret from the shareholders, who unwittingly were made to bear the cost of this largess and which therefore could be seen as a securities fraud.

A large number of class action lawsuits were brought against directors and others for claimed breaches of fiduciary duty arising from this backdating, but in the years when this was happening many observers sought to minimize the wrongfulness of the conduct. From much of the commentary at this time, one could easily get a sense that these were mere technical violations and that it would all turn out to be much ado about nothing – i.e., no more serious than meeting a year-end deadline by working until “December 38th” seemed at the time it was happening.

However, in a recent post in the D&O Diary, Adam Savett, Director, Class Action Services at KCC, surveys the relevant cases and notes that “early prognosticators … were significantly off in predicting outcomes … of [these] cases. The settlements were not insubstantial, having a combined value of more than $2.38 Billion….” Also, 82% of the cases settled – a considerably higher number than the historical average for securities class actions (65%).

Also noteworthy here is a comment on the D&O Diary posted by Michael Klausner and Jason Hegland of the Stanford Law School to support Savett’s “point that the options backdating cases turned out to [be] serious…” They note: “Individual defendants made above-average personal, out-of-pocket payments into settlements of backdating cases” and “[t]he percentage of settlements paid fully or partially by insurers was lower in backdating cases than in other cases.”

How can C&E professionals use this page of history in training directors and officers? Not to show that backdating is wrong, as I think that would (now) be seen as unnecessary. Rather, and together with other scandals involving directors (see discussions collected here), the backdating cases can be used to make a more general point about the need for directors to have a heightened sense of ethical awareness. Put otherwise, directors and officers should not count on their instincts – or insurance – to save them from the consequences of an ethical lapse.

In “Teaching Behavioral Ethics” – which will be published next year by the Journal of Legal Studies Education, and a draft of which can be found here – Robert Prentice of the McCombs School of Business at the University of Texas presents his pedagogical approach to behavioral ethics. The paper should be useful not only to other business school professors in preparing their own ethics classes but also to C&E professionals who are considering training business people on “‘the next big thing’ in ethics…”

Prentice’s article describes in considerable detail what he covers in each session of his course. The first addresses why it is important to be ethical, including the many positive as well as negative reasons, and the second the sources of ethical judgments, with a key point being that such judgments tend to be more emotion based than is commonly realized.

The next few classes are about “Breaking down the defenses,” which make the overarching behaviorist point “we are not as ethical as we think” and which explore many key concepts in the field, including self-serving bias; role morality; framing; the effect of various environmental factors – such as time pressure and transparency – on ethical behavior; obedience to authority; conformity bias; overconfidence; loss aversion; incrementalism; the tangible and the abstract; bounded ethicality; ethical fading; fundamental attribution error; and moral equilibrium. Prentice also discusses research showing that “people are of two minds,” and “tend to be very good at thinking of themselves as good people who do as they should while simultaneously doing as they want,” as well as the related facts that we often don’t do a very good job in predicting the ethicality of future actions and are not especially accurate in remembering the ethicality of our past actions. At various points in the paper he illustrates these phenomena not only with behavioral studies but also with well-known cases of legal/ethical transgression (e.g., Martha Stewart’s conviction for obstruction of justice as a possible manifestation of loss aversion).

The final part of Prentice’s course is aimed at helping students be their “best selves.” This begins with teaching the differences between the “should self” and the “want self,” and the importance of incorporating the needs of the want self in advance, e.g., by rehearsing what one would do if faced by a particular ethical dilemma. Also important to being one’s best self is “keeping one’s ethical antennae up….[to] always be looking for the ethical aspect of a decision so that [one’s] ethical values can be part of the frame through which” a problem is examined. As well, Prentice exhorts his students to “monitor their own rationalizations,” and use pre-commitment devices to decrease the influence of the “want self.” Finally, he discusses research by Mary Gentile showing that more often than is appreciated, “one person can, even in the face of peer pressure or instructions from a superior, turn things in an ethical direction if only they will try.”

All told, this seems like a great course, and I wish that it could be taught in every company as well as in business school. Of course, those providing C&E training in the workplace typically are not given a semester’s worth of time to do so, and indeed there seems to be a recent trend in the field of C&E training – particularly given the “training fatigue” that one finds in some companies – to try to do more with even less. However, I do think some of the behavioral notions discussed in Prentice’s article can be the basis of compelling workplace training.

First, the fact that it is a relatively new area of knowledge, that it is science based and that it is clearly interesting can make behavioral ethics more appealing to business people than a lot of traditional C&E training. Indeed, using behavioral ethics ideas and information can be a welcome relief from “training fatigue.”

Second, the lessons about how to become our “best selves” are indeed quite practical, and for that reason should be welcome in the workplace. Indeed, given the many careers that have been damaged/destroyed by business people not keeping their “ethical antennae up,” these lessons should be seen as business survival skills.

Third, the totality of these studies showing we’re not as ethical as we think helps makes the case – as well as any legal imperative ever could – for the need for companies to have strong C&E programs. This should be part of any C&E training (as well, in my view, business school ethics classes), but is particularly important to include in training of boards of directors and senior managers.

Finally, directors and senior managers have an espescially strong need to learn about behavioral ethics research showing that those with power tend to be more ethically at risk than are others, as discussed in various prior posts – such as this one (review of an important paper by Scott Killingsworth), this one and this one, to which should be added this recently posted paper about a study to showing that “employees higher in a hierarchy are more likely to engage in deception…” than are others. To my mind, the prospect of helping companies with the politically sensitive task of bringing sufficient compliance focus to bear on their heavy hitters is as important as is any of the other possible real-world contributions of this promising and fascinating new field of knowledge.

In today’s post we conclude our interview with Steve Priest. Information about Steve, and Part One of the interview, can be found here.

Should ethics training be a stand-alone offering or is ethics part of broader training (compliance, leadership, etc.)? Jeff, I wish I had 1%–even 1/10 of 1%–of the money companies have wasted on ethics and compliance training in the past 20 years. There is some evidence that training that is risk and role based—and is targeted, short and engaging—can improve employee perceptions of management commitment, and perhaps even decrease the likelihood that they will engage in stupid, unethical or non-compliant behavior. On the other hand, let’s look at the somewhat prominent school in Princeton, your beautiful town. Dan Ariely’s research there found that taking a week long morality course did not affect the rates at which Princeton students cheated in an experiment one week later. What did make a difference? A reminder right before the experiment about the school’s honor code. Short, sweet, targeted, proximate—these were the keys even before the Twitter/Angry Birds generation. So integration makes a lot of sense because we can have much more frequent, relevant touch points.

What works and what doesn’t when it comes to training boards on ethics? Same question with senior managers. In the past two months I had the opportunity to train the board of one of the world’s largest energy companies and one of the world’s largest retailers. In the latter case it was the third time they asked me. I think the secret is no secret: board members and senior leaders view themselves as very smart, successful, and ethical. And for the most part they are. Respecting that, and building training that is engaging and relevant to their roles and responsibilities works with senior leaders just like it does with front line employees. Cases and conversation make it real and relevant.

You’ve done ethics & compliance work in close to 50 countries. Can you describe some of the pitfalls that one can face when training without being sufficiently attuned to the local culture? A number of years ago I was conducting training in Moscow when a person raised his hand and said “You are from Chicago, right?” “Yes.” “Well, I am from Yekaterinburg, and we have hundreds of missiles aimed at you right now.” Usually the defensiveness is not so overt, but it is always in the room. The biggest danger is the perception of (misplaced) ethical superiority. That is, it is very easy for people to interpret that the reason that an American/Brit/etc. is coming over to conduct ethics/compliance training is because it is believed that the US/Great Britain is ethically superior to whatever country you are in. I address this head on first thing by talking about how I am from Chicago, listing several of the ethical challenges we have faced, and acknowledging that I don’t have all the answers but have become pretty good at thinking about these things. I also try to tap into local ethical heroes or foundations to illustrate that this is not a Western issue—ethics is important in every culture.

As noted in a previous post, CEO’s tend to have different COIs than the rest of us. Today’s post will look at a few CEO-related COI stories that have been in the news lately.

Most notably, yesterday the pharma company Novartis dropped a controversial plan to pay outgoing CEO Daniel Vasella up to $78 million over the course of six years. As described by Forbes, “The board had originally justified its decision in order to ‘protect’ the drug maker, since Vasella knows ‘the company’s business intimately, having built the leading R&D organization and personally recruited most of the top executives.’ In other words, the payoff was hush money designed to keep him from telling secrets to competitors.” The notion that a board could even consider paying a CEO something extra for keeping shareholder secrets is – at least on its face – pretty distressing.

Public sector organizations have CEO’s, too – and various press accounts have noted that super-lawyer Mary Jo White, who President Obama has nominated to head the Securities and Exchange Commission, will need to take conflict avoidance measures if confirmed for that post. But as noted in this recent story in Bloomberg News, while it is hardly unusual for a lawyer going from private practice to public service to have COIs of this sort, White’s particular contemplated mitigation approach to her potential COIs (which concern not only her law firm partnership but that of her husband, himself a prominent securities lawyer) appears to be of less than optimal efficacy.

I should stress that I don’t think there is any chance that White will personally act in a conflicted way in the discharge of her duties at the SEC. But individual honesty is presumably not the end of the analysis regarding any leader’s COIs – and that is particularly so where a) the leader leads a government agency whose mandate includes, among other things, addressing COIs (at least in the financial services field); b) that agency has an uneven record over the years in enforcing that mandate; and c) there is a reasonably strong concern among press and public that the reason for the agency’s shortfall is one of regulatory capture.

And speaking of the SEC, there is this story from yesterday about a deposition of hedge fund chief Steve Cohen whose firm, SAC Capital, is being investigated for insider trading. Cohen apparently testified: “I’ve read the compliance manual, but I don’t remember exactly what it says,’’ and, according to John Coffee, a noted securities-law professor at Columbia, “That’s a dangerous statement. The fact that he doesn’t know what’s in his compliance manual is useful to the SEC,” should it decide to pursue the firm on a “control person” theory of liability (which essentially involves supervisory neglect).

But is this really a COI issue? It is in the sense that under Delaware law compliance oversight failures by directors and officers can be deemed a violation of the duty of loyalty, which – even if not technically involving a conflict – is from the same neck of the woods as COIs.

First, this recent story from Bloomberg news reported on possible conflicts involving a prominent university’s board: “13.5 percent of Dartmouth’s $3.5 billion endowment is managed by firms that are related to trustees or investment committee members.” Dartmouth is not alone in this respect, but some schools do ban the practice, based on COI concerns: “Trustees shouldn’t manage university money because of the potential for self-dealing and other abuses, says Mark Williams, a former Federal Reserve bank examiner who teaches risk management at Boston University. ‘Even the appearance of conflicts of interest can create reputational risk and harm the institution,’ Williams says. ‘The perception is almost as bad as the act of conflict. It does damage to that reputation, which has taken many universities centuries to create.’”

On the other side of the coin, the alumni in question have apparently been very generous in their gifts to the school, so it is arguable that on a net basis the practice is worthwhile – although balancing tangible gains against possible intangible losses is hardly an easy calculus to undertake in any meaningful way. The piece also noted: “The potential conflicts can be thrown into high relief when funds lose money. As chairman of Yeshiva University’s investment committee, J. Ezra Merkin funneled the school’s money via his hedge funds to con man Bernard Madoff in return for fees. The $1.1 billion endowment lost $14.5 million when Madoff’s Ponzi scheme blew up in 2008.”

I don’t know what to add to this except the general comment that many non-profit organizations (i.e., not just universities) could use more rigor in their approaches to COIs. Here is a piece that speaks to that.

Second, this recent post, by Klaus J. Hopt, a professor and director (emeritus) at the Max-Planck-Institute for Comparative and International Private Law, in Hamburg, on the Harvard Law School Forum for Corporate Governance makes an interesting comparison between the duty of loyalty owed by directors under US and UK law and the prevailing approach under the continental system: “The duty of loyalty is highly developed in Anglo-American countries, but it has received more hesitant attention in continental European countries.” However, the piece notes: “More recently there are tendencies to more convergence [and] more attention is paid to prevention, remedies and enforcement.”

At the risk of sounding US centric (whereas I’m really just COI-centric), this does sound like a positive development. Moreover, and beyond the scope of Professor Hopt’s paper (which can be downloaded via the Harvard site), it is interesting to consider that under Delaware law (in particular the Stone v Rittercase) a board’s compliance and ethics oversight duties are actually based on the duty of loyalty – and perhaps the convergence will extend in that direction, as well.